How to Make Loans Scarce in Two Words: Cap Rates

Interest Rate Caps

Reuters reports Peru Passes Law Allowing Central Bank to Cap Interest Rates on Bank Loans.

Peru’s Congress approved on Wednesday a law that will allow policymakers to cap interest rates on loans granted by banks, a controversial measure that has been deeply critiqued by the Andean nation’s government and financial institutions.
 

The law empowers the country’s central bank to set maximum and minimum interest rates every six months in order to regulate the loan market, a measure lawmakers said is necessary to protect Peruvians from abusive lending practices.

Loophole

The loophole in the bill is that it “allows” rather than “requires” the Central Bank to cap rates on bank loans.

Regardless, this is a horrible idea.

If the Central Bank or government set rates that are too low, loans will dry up. 

This is similar to Venezuela setting the price of gasoline at 10 cents a gallon. That’s the official price but the supply at that price is zero.

The government set the price of gasoline but it cannot secure the supply. 

The result is a huge black market. 

What About the Fed?

The Fed does not set bank loan rates directly, but it does influence them. 

For example, mortgages loan rates are generally tied to interest rates on 10-year US Treasuries that the Fed does manipulate.

Interest Rate Floors and Subsidies

Unlike the setup in Venezuela, the Fed can indeed provide all the supply of dollars it wants. And as long as borrowers use the money for speculation, housing, and other items that do not show up in official inflation stats, the Fed can get away with it.

Low interest rates helped fuel the stock market bubble and other speculative activities. The result is three major bubbles in 20 years, with allegedly low inflation. 

Few see the current bubble only because it has not popped yet.

These are all good reasons to end the Fed and let the market set rates.

Mish